Looking Beyond COVID-19 — Biden Proposals — Vaccine Rollout Key to Snapback — Limited Multiple Expansion — Focus on Cyclical EPS Growth

Vaccine Rollout Key to First Half Growth—Potential New One-Dose Vaccine

The speed of reaching broad-based vaccinations will likely determine how fast the economy snaps back. Post-vaccine activity will initially depend importantly on economic momentum pre-vaccine. State funding in the last COVID package plus the new Biden package should accelerate the current disappointing vaccine rollout. Additionally, a new single-dose vaccine coming off trials in the next month or so will provide a further shot in the arm for the rollouts with its simpler logistical requirements.

Third COVID Rescue Package Size and Speed Depends on Bipartisan Support

Near-term, President Biden will propose a $1.9 trillion relief package (nearly 10% of GDP) covering a broad spectrum of programs. The proposed rescue package will extend supplemental unemployment coverage to the end of September, increase individual checks from $600 to $2000, broaden funding to state and local governments by $350 billion, and accelerate vaccine rollouts and testing. How fast the Congressional legislative process works depends on whether faster regular order, which requires 60 votes in the Senate or a more complex budget reconciliation process applies. In addition, the delays will result from the Senate impeachment trial. After the Obama administration took office in 2009 following the Great Financial Crisis (GFC), President Obama signed a stimulus package on February 17th — one month after taking office. At that time, Democrats controlled the Senate with 60 votes — not the case today. The Biden proposals total fifty percent larger than the Obama stimulus — inflation-adjusted. With the current senate makeup, regular order will require bi-partisan support to achieve sixty votes needed for passage. With their complexity, these proposals might be broken up into separate legislation so that some could be fast-tracked with bipartisan support.

Many Consumers Will Save Their COVID Checks—Savings Initially Could Help Power the Snapback

Many consumers will save a large proportion of their $2,000 checks. High levels of savings reflect, among other factors, both limited availability of and health concerns using consumer services such as restaurants, travel, and leisure activities (see Figure 1). Record consumer savings and vaccinations will likely contribute to an economic snapback sometime in the second half as consumer services open up. With increased savings, Robinhood’s merry men (80% are men) will likely use some part of their savings to pursue increased options and stock trading. Above normal option trading levels increases volatility, which becomes noticeable during market downturns.

Figure 1

How Consumers Will Spend $2000 Checks

Major Infrastructure Spending Extends Snapback Through 2022

Shortly, the Biden administration will follow up with major fiscal spending programs to meet needs their campaign featured as “Build Back Better.” These programs would include major broad-based infrastructure programs that should receive bipartisan support. Other programs would include the so-called Green New Deal (see our commentary 1/6/2021), as well as expanding healthcare subsidies. Enactment of these proposed programs would likely occur later in the second half of this year or early in 2022 — with a minimum estimated $2 trillion of spending spread out over four years. These spending levels should extend the likely economic snapback through 2022.

Success of COVID Income Supplement Plans Could Lead to Universal Basic Income Programs

Success of CARES checks and expanded unemployment support provided a policy victory for the Keynesians. The economy showed a historic GDP decline in the 2020 second quarter. At the same time, government social benefits from the CARES programs then produced a record rebound in disposable personal income (see Figure 2). Based on this success, Treasury Secretary designee Janet Yellen, as both a Keynesian and labor economist, might look to broadly strengthen the counter-cyclical safety net. This might provide a basis, if progressives can win the day in 2022 Congressional elections, for universal basic income (UBI) programs.

Figure 2

Net Change in Disposable Personal Income Since 2019 (Annual Rate)

Higher Tax Rates 2022 — Higher Revenues Result–Still Higher Budget Deficits Continue

The administration will look to raise revenues — higher tax rates — to finance these new programs. President-elect Biden, in his campaign, proposed raising taxes nearly $4 trillion over ten years. The top one percent earners would pay nearly three-quarters of that total. Biden tax proposals will seek to raise corporate tax rates from 21% to 28%. For individuals, top tax rates would rise from 37% to 39.6%. For those filing joint returns, top tax rates would start at $466,950 compared to $622,051 currently. The Biden tax proposals would also raise the tax rates on dividends and capital gains to top earned income tax rates for those earning over $1 million. With Biden’s very aggressive COVID stimulus programs, his tax proposals may go beyond his campaign platform, putting further tax pressure on the wealthy. No matter the revenues raised, budget deficits will continue to grow from their already high levels. Fixed income markets will take note.

Passage of Biden Proposals Depends on the Senate Center of Both Parties — Schumer Subplot

Narrow democratic majorities in both Senate and house may lead to a somewhat more moderate tax rate increases than Biden’s proposals. The so-called senate Democratic mod-five and center-right Republican senators will play a key role in eventual tax rate increases — as well as other new fiscal programs. Progressives may oppose increasing state and local property tax (Salt) deductions beyond the current $10,000 as favoring upper-income earners. Whatever the final tax rate increases, they will not likely become effective until 2022. In a sub-plot, Alexandria Ocasio-Cortez may primary against democratic leader New York Senator Schumer. That possibility might cause Senator Schumer to tilt some programs to a more progressive mix.

Long-Term Inflation Increase Likely Responds to Both Lower Labor Market Slack and Recovery of Service Sector

Recently, 10-year yields increased from 0.93% on January 4th to fractionally over 1.1% currently. Rising long-term interest rates reflect concerns that inflationary pressures will respond to increased fiscal spending and economic snapback. In our view, the economic snapback will quickly bring stronger pricing as consumers find more ways to spend their accumulated savings — particularly for consumer services. Long-term inflation will likely respond to how fast labor market slack falls resulting in increased wages. Reducing that slack will, in part, again, depend on how fast depressed consumer service employment recovers (see Figure 3).

Figure 3

Change in Private Sector Employment Since January 2020 by Sector

Financing Higher Budget Deficits — Leads to Higher Trade Deficits — Brings Pressure on the U.S. Dollar

New and increased fiscal spending programs will push up deficits beyond already historically high levels. To fund these growing budget deficits will require even greater funding from international sources. Very simply, our dependency on international sources for funding our Federal debt increases as our net national savings rate declines. Our net national savings rate—the sum of savings by businesses, households, and government — will likely remain under pressure as Federal deficits grow (see Figure 4). Therefore, our ability to fund increasing Federal budget deficits will lead to growing trade deficits bringing long-term pressure on the U.S. dollar (see Figure 5). With that, domestic prices will reflect higher pricing on goods and commodities.

Figure 4

Net Savings as a Percentage of Gross National Income

Figure 5

U.S. Non-Petroleum Trade Balance ($ Billions)

Investment Conclusions

2021 Equity Market Performance Dependent on Eps Growth Not Multiple Expansion

Successful fourth quarter vaccine trials gave investors sufficient confidence to look for an economic snapback beginning in the second half of 2021. Their confidence led to fourth-quarter 2020 equity markets growth far outperforming the growth of corporate earnings per share (see Figure 6). However hopeful, vaccine trials will not prove sufficient to judge the potential second-half economic snapback. Instead, judging the speed of vaccine rollouts will likely prove critical to the timing and which sectors (see below) will benefit from the snapback. That snapback will prove key to producing sufficient earnings growth to reduce dependence on multiple expansion for equity market performance. This will become even more important with potentially rising interest rates.

Figure 6

Cyclical companies – capital spending recovery

The current economic outlook, in our view, will continue to benefit cyclical companies—many of which also fall into the value category. While these stocks surged with the recent equity market upswing, in our view, this snapback will not prove short-term. Proposed new fiscal spending programs should spark capital investment in infrastructure and alternative energies, sustaining a longer cyclical stock recovery.

Commodities — Underinvested Production Capacity

Stimulative monetary and fiscal spending programs globally joined by the current recovery in China should lead to the synchronous rebirth of global growth later in 2021. This outlook should benefit many hard commodities as well as oil. Underinvestment in production capacity for both groups should prove key to their attractiveness. While green energy likely represents the future, it would not be surprising to see what may prove to be the last hurrah for oil during this cycle. Higher oil prices will likely reflect the largest decline in energy investment on record, -20% in 2020 according to the IEA. Despite the likely rise in commodity prices, inflationary pressures should remain relatively controlled as long as wages show little pickup. Labor market slack should preclude any near-term wage pressures.

Fixed Income – Shorter-Duration

The cyclical snapback will likely lead to rising interest rates in reaction to possible signs of gradually increasing inflation. Having Federalized fixed income markets, the Fed may still hold off attempting to moderate the yield curve’s upward tilt unless unexpected pressures result. Nonetheless, with that outlook, investors should stick with shorter-duration fixed-income investments. This will avoid the price risk longer duration debt faces from rising interest rates.

Pandemic Disruption — Democratic Control — Opportunity for Active Managers

The disruptive nature of the pandemic will force many business sectors and companies to reposition themselves to meet this change. Adding a rollout of new fiscal programs from democratic controlled Washington creates opportunities for active managers to differentiate their investment selection skills. These forces may lead investors to selectively consider making greater use of actively managed funds.